Nestle $2-a-Shot Nespresso Propels Premium Brand Profit

By Dermot Doherty -
Feb 13, 2013

Nestle SA (NESN) has found something even better than single-serve coffee costing twice as much as ground java: a version that costs eight times as much.

While consumers worldwide rein in spending, the Swiss company in October introduced Hawaii Kona Special Reserve, a limited edition coffee for its Nespresso machines. At $2 a shot, it cost four times the price of regular Nespresso. It sold out within weeks, and the company says more such offerings are in the works.

The Kona brew is part of a broader push upmarket that has helped the world’s largest food company boost profitability beyond that of rivals such as Unilever and Danone. (BN) Analysts say the effort helped Nestle’s 2012 sales growth exceed the company’s annual target of about 6 percent.

Under Chief Executive Officer Paul Bulcke, the company has accelerated the introduction of such products to give consumers a reason to stick with Nestle brands such as Nespresso, Moevenpick ice cream and Maison Cailler chocolate rather than defect to private labels.

“Nestle is probably more advanced than others in its quest for premiumization,” said Marco Gulpers, an analyst at ING in Amsterdam. “The move is clearly away from the middle where you have private label competing with brands.”

Cheap Yogurt

Supermarkets have expanded their house-brand offerings over the past decade, undercutting big-name products as consumers seek to trim household spending. Danone, the world’s biggest yogurt maker, has lost market share in southern Europe over the past year as shoppers, particularly in Spain, have switched to lower-priced store brands. The Paris-based company in June cut its forecast for full-year profit margins because of declining consumption in the region.

Nestle’s revenue probably increased 6 percent in 2012, excluding acquisitions, divestments and currency shifts, according to the average of 11 analyst estimates. When it releases its 2012 results tomorrow, the company will say higher-end products such as Nespresso have helped boost profitability, analysts predict.

Nestle shares have gained 8.3 percent this year and 20 percent over the past 12 months. The stock traded 0.5 percent higher at 64.60 francs at 1:36 p.m. in Zurich. A close at that level would be a record. Aside from a dip at the end of last year, Nestle has had a higher price-earnings ratio than rival Unilever (UNA) since 2006. The company trades at 22 times earnings, while Unilever is at 18 times.

Infant Formula

Nestle has expanded the beverage-machine concept behind Nespresso, which makes coffee from grounds delivered in an aluminum pod. In 2011, the company added BabyNes, infant formula reconstituted in a 249-Swiss franc ($271) machine from capsules costing about 2 francs per serving. And in 2010 it introduced Special-T, a machine that makes more than 25 types of portioned tea from capsules costing as much as 20 euros for 10 pods.

Nestle’s Maison Cailler brand offers chocolates that shoppers can customize with fillings ranging from peppercorn and vanilla to raspberry and verbena. Prices start at about 20 francs for a box of 16 pieces. And it’s expanding its network of boutiques selling Moevenpick ice cream for almost $5 a scoop.

Philadelphia Chocolate

Unilever last month said revenue excluding acquisitions and currency shifts at its food division expanded 1.8 percent last year to 14.4 billion euros ($19.3 billion) with growing sales of products such as Flora Cuisine liquid margarine, which costs about twice what standard sunflower oil does. Kraft Foods Group Inc. (KRFT) and its spinoff Mondelez International Inc. (MDLZ) have introduced more expensive versions of Philadelphia cream cheese, including one with Milka chocolate.

Nestle gets about 15 percent of revenue from high-end beverages and snacks, versus less than 10 percent five years ago, according to Jon Cox, head of Swiss research at Kepler Capital Markets in Zurich. For Unilever, the high end represents about 10 percent of sales and at Mondelez it’s about 5 percent, Cox said.

Since taking over from Peter Brabeck-Letmathe five years ago, CEO Bulcke has continued Nestle’s commitment to other high-margin businesses. Nestle in April agreed to buy Pfizer Inc. (PFE)’s infant-nutrition unit for $11.9 billion, boosting the Swiss company’s revenue from fast-growing emerging markets. And two years ago it set up a health-science unit to develop personalized nutrition treatments for conditions such as diabetes, obesity or heart disease.

“Nestle already had the nutrition, health and wellness mantra, then Bulcke came in and said, ‘and premiumization,’ and it’s getting ingrained into the culture,” Cox said.

Dolce Gusto

Nestle’s trading operating margin, a measure of profitability, rose to 15.3 percent from 15 percent in 2011 and 14.4 percent a year earlier, analyst estimates show. The company, based in Vevey, Switzerland, has said it aims to improve the margin each year based on constant currencies.

Unilever last month reported a core operating profit margin of 13.8 percent for 2012. Danone has forecast that its operating margin narrowed by a half percentage point last year from 14.7 percent in 2011.

More companies are expanding into premium products compared to five years ago because they can make more money at the high end, said Julian Lakin, head of research at Mirabaud Securities in London.

Nestle in October said it was expanding its offering of premium products in emerging markets after introducing Dolce Gusto coffee capsules in 10 countries in Asia, Africa and Oceania. Dolce Gusto, which makes espresso and milk-based coffee drinks such as Cappuccino Ice and Chococino, is cheaper than Nespresso though still considered a high-end product.

Moscow Leather

“Premium space equals premium margin,” Lakin said. “Plus you’ve got a load of people in developing markets who are aspiring to premium, so it has significant attractions.”

In November Nestle opened its first Moevenpick boutique in Russia, which has become the second-biggest market for the ice cream. At the boutique, with black-leather seating and red walls, a scoop of Moevenpick costs roughly four times the price of ice cream from a street vendor in the city. Nestle acquired the brand in 2003 and now markets it in more than 30 countries.

Nespresso is the biggest contributor to Nestle’s upscale effort. The brand had revenue of 3.5 billion francs in 2011, or 4 percent of Nestle’s sales. The fastest-growing regions for Nespresso and Dolce Gusto are Asia, Africa and Oceania, where the opportunity for premium sales is “huge,” according to Warren Ackerman, an analyst at Societe Generale in London. And Nestle now sells Special-T capsules in seven European countries after introducing the brand in Switzerland and France in 2010.

Nespresso “wouldn’t have the staying power if it were not a fantastic product,” Ackerman said. “Special-T will grow very quickly from a low base, but I doubt it will ever have the same broad appeal of Nespresso because the difference between instant or even roast and ground and the quality of Nespresso is huge, whereas the difference is likely to be less marked in tea.”